1. Field of the Invention
The present invention relates generally to the fields of lending and leases, and more particularly to the creation of a loan based on a plurality of notes from a lease revenue stream.
2. Background
Single tenant properties that are net leased to credit tenants are an important subset of the overall commercial real estate market. For a variety of strategic, competitive and accounting reasons, many corporations choose to lease properties rather than own the underlying real estate. These types of properties are generally owned by developers who have built the properties, or individuals or corporate owners who purchase them after construction is complete.
Owners of single tenant properties net leased to investment grade companies have historically been financed by banks and insurance companies. This type of loan is based on the creditworthiness of the underlying lessees/tenants and thus relies little on the liquidation value of the property.
Moving down the credit quality curve, the available options for borrowers become fewer and fewer. Prior to the establishment of the public capital market based credit tenant lease (“CTL”) lending business created by Capital Lease Funding L.P., (“CLF”) in 1995, owners of properties net leased to marginal investment grade (as well as sub-investment grade) tenants have traditionally been financed by traditional real estate lenders which base their loans more upon the conventional real estate values of the properties rather than on the underlying credit strength of the credit tenants, resulting in lower amounts of leverage.
The underwriting analysis for a conventional real estate loan relies heavily on the liquidation value of the real estate securing the loan, the ability of the borrower to adequately address property operations and the borrower's ability to adequately address re-leasing and re-tenanting of the property due to tenant rollover, among other things. Due to these uncertainties and fluctuations in operating income of the underlying property, the loan proceeds from a conventional real estate loan are generally lower than the appraised value of the property (typically no more than 80%) and the debt service coverage ratio is typically no less than 1.20.
The CTL lending business created by CLF in 1995, was instrumental in establishing a viable credit tenant lending program for a variety of types of investment grade tenants and varying qualities of credit tenant leases for which CTL loans were not previously available. The ability of CLF to underwrite and securitize high leverage CTL loans to owners of single tenant properties for substantially all categories of investment grade tenants had provided owners and borrowers with an attractive alternative to traditional forms of funding for these properties, particularly for those leased to marginal investment grade credits.
CLF operates as a specialty lender originating CTL mortgage loans made primarily to all types of investment grade tenants under leases ranging from 10 to 25 years in length. Each credit tenant loan is secured by a first mortgage on a commercial real property subject to a long term net lease to a credit tenant and by an assignment of the credit tenant lease and all rents due under the lease. Under a credit tenant lease, the principal parameter underlying the transaction is the credit quality of the applicable tenant rather than the credit quality of the borrower or the liquidation value of the property. The underwriting analysis for a credit tenant loan consists primarily of an analysis of the credit and business profiles of the credit tenant and the credit tenant lease. The typical credit tenant loan made by CLF has a 20 year term and is fully amortized by scheduled rent payments under the credit tenant lease. As a result, CLF's credit tenant loans (which approach a ratio of scheduled rent payments to debt service of 1.0) tend to have debt service coverage ratios lower than conventional mortgage loans, as well as higher loan to value ratios, approaching 95%.
Lease Types
Historically, CTL loans, which were characterized by high leverage with debt service coverage ratios approaching 1.0, were made to property owners who have net leased their property to tenants having an investment grade debt rating from a nationally recognized statistical rating agency (“Rating Agency”), but were only available when the applicable lease was a “bond” type lease. In a bond type lease, the credit tenant is responsible for every monetary obligation associated with managing, owning, developing and operating the leased premises including, but not limited to, the costs associated with the utilities, taxes, insurance, maintenance, ordinary and capital repairs and replacements and losses due to a casualty and/or a condemnation. The credit tenant has no ability to terminate or abate rent under a “bond” lease. Consequently, loans secured by “bond” leases are analyzed as if they were direct obligations of the applicable tenant.
Double and triple net leases are generally long term leases to tenants who are responsible for paying most of the costs of owning, operating, and maintaining the leased property during the term of the lease, in addition to the payment of a monthly net rent to the lessor for the use and occupancy of the premises. Under double and triple net leases, in contrast to “bond” leases, a tenant has the right to terminate the applicable lease or abate rent thereunder upon the occurrence of a significant casualty or condemnation. Under a double net lease, the tenant may terminate the lease or abate rent thereunder, upon the failure by the lessor to maintain or repair the property, provide adequate parking, maintain common areas or comply with other affirmative covenants of the lease, or if the lessor leases property to a competitor of the credit tenant within a specified radius of the property or otherwise violates other negative covenants in the lease.
The financing of double net and triple net leases to investment grade tenants as CTL loans was pioneered by CLF in 1995. Previously, double net and triple net leases had been traditionally financed as conventional real estate loans. CLF's specialized lease enhancement mechanisms substantially mitigate the risk of potential interruption in the rental stream so that such double and triple net leases can be evaluated as if they were “bond” leases. CLF's lease enhancement mechanisms comprise primarily an integrated set of specialized insurance policies, servicer advancing mechanisms, and various borrower reserve funds. These mechanisms support the lessor's maintenance and other obligations under a credit lease in order to mitigate the risk of rent abatement or lease termination by the credit tenant due to the failure of a lessor to perform its obligations.
Commercial Mortgage Backed Securities Market
The commercial mortgage backed securities (“CMBS”) market was established initially as a vehicle to liquidate the commercial mortgage loans held by the RTC resulting from the S&L financial crisis. The CMBS market has now grown into an approximately $80 billion annual market, with strong liquidity, strong research and a wide following by many institutions. With the maturity of the CMBS market, CMBS pools have now become homogenous in terms of the collateral type and underlying commercial mortgage loan terms. The current CMBS securities market is structured such that the majority of the securities created from the underlying mortgage loans have 10 year final maturities, whereas the securities created from CLF's long term CTL loans have final maturities ranging from 15 to 25 years.
The CMBS 10-year “AAA” security has also become a very liquid “benchmark” security and investors will generally pay a premium for this liquidity while, on the other hand, they will “punish” other types of “off the run” (i.e. non-conforming) CMBS securities, which are not perceived as being as liquid. Thus, as the CMBS market has matured, it has become more difficult to sell “off-the-run” CTL securities, which often have final maturities beyond 10 years, in the public CMBS capital markets. In addition, from time to time as prevailing economic conditions worsen and saturation in the marketplace of certain credits develops, there may be limited demand and diminished liquidity for CTL securities backed by many types of investment grade tenants in both the CMBS market and the private whole loan market at any given time.
Thus, a current problem is the need for more liquidity in the public and private capital markets for securities created from high leverage CTL real estate loans based upon lease revenue streams from long-term credit tenant leases.